Is De-Dollarization Real?
(This
is for information purposes only. This should not be construed as a
recommendation or investment advice even though the author is a CFA Charterholder. Please consult your financial
adviser before taking any investment decision. Safe to assume the author has a vested
interest in stocks / investments discussed if any.)
There are genuine concerns about threats to US dollar as a preeminent currency globally. What are those threats and are fears of end of US dollar dominance real?
1. What is De-dollarization?
The US dollar dominates in international trade, holdings of foreign exchange reserves by countries and in international corporate financing.
Some countries, especially China and Russia, have been trying to move away from US dollar due mainly to political reasons. After it invaded Ukraine, Russia is cut off from SWIFT payment system and other international trade as the US and Europe imposed economic sanctions on Russia.
This process of several countries trying to reduce their dependence on US dollar for international trade and to hold less of their foreign exchange reserves in the US dollar is known as de-dollarization (or de-dollarisation).
2. US dollar Share in Forex Reserves Declines
The
share of US dollar in official foreign exchange reserves of 149 countries has been
declining in the past decade. The
US dollar is still predominant in the composition of foreign exchange reserves.
The euro currency is at a distant
second, according to data from International Monetary Fund (IMF).
As shown in table 1 below, the USD share has declined from 65.2 percent in June 2016 to 58.9 percent in June 2023, while Euro's share has more or less remained stable at 20 percent during the same period.
One key thing to note is exchange rate movements play a major role in currency composition of forex reserves held by countries. This could partly explain the decline of USD share.
In addition, some central banks have been trying to diversify their reserve assets away from dollar.
Chinese Yuan (Renminbi) entered IMF's forex reserves data for the first time in December 2016. Its share is a piffling 2.5 percent now even though China has been trying to encourage its currency globally for international trade.
As shown in Table
1, the US dollar lost share and other major currencies,
JPY, GBP, CAD and CNY have gained. But there may be some nuances here.
As
analysed in a BIS paper, the currency composition of foreign
exchange reserves relates strongly to the co-movement of the domestic currency
with key currencies and the currency invoicing of trade.
The greater the co-movement of the domestic
currency with the dollar (euro), the higher its dollar (euro) share of official
reserves.
The
share of Euro area (eurozone) in world GDP is less than 20 percent and its
share in global trade is about 11 percent. The share of euro in global forex
reserves is 20 percent – this is more or less in line with Euro area’s share in
world GDP and global trade.
Table
1: Share of Major Currencies in Fx Reserves:
Two reasons for the decrease in USD share in reserves in the past few years:
-- bond market valuations declined precipitously in 2022 and 2023 due to rising US interest rates since March 2022
-- the US dollar was sold off in 2022 due to its extreme strength (as reflected in the rise of US dollar index or DXY)
Many
countries still tend to hold most of their foreign exchange reserves in the US dollar, because the US
is seen as a safe haven -- making the US dollar as their reserve currency.
3. SDR Basket and Chinese Yuan
The
International Monetary Fund (IMF) added, effective 01Oct2016, Chinese Yuan
(CNY) to Special Drawing Rights (SDR) Basket. CNY joins US dollar, euro, Japanese yen,
and British pound in SDR basket. The decision to add CNY to SDR basket was
taken by IMF in Nov2015.
The
SDR is an international reserve asset.
The SDR is not a currency, but its value is based on a basket of five
currencies—the US dollar, the euro, the Chinese yuan, the Japanese yen and
the British pound sterling.
After
its inclusion in SDR basket, CNY's weight in SDR basket grew to 12.28 percent as per 2022 review by IMF.
Table
2: SDR Valuation Basket and Weights:
4. Reasons
for dollar dominance
The
share of US economy in world GDP is almost one-fourth. And it has an equal
share in global trade. The invoicing for a majority of exports and imports is
done in US dollar globally.
The
US also has a large bond market, providing easy access to countries to park
their reserves in dollar-denominated US Treasury bills, notes and bonds. The US has one of the strongest military forces in the world.
According to a BIS update, the US dollar was involved in nearly 90 percent of global foreign exchange transactions, making it the single most traded currency in the forex market.
Around fifty percent of all international debt instruments and cross-border loans issued in offshore funding markets are in USD.
Approximately half of global trade is invoiced in USD.
As shown in tables 1 and 2 above, the US dollar still dominates in countries' forex reserves and it has the highest share in IMF's SDR basket.
Due to these advantages enjoyed by the US dollar, most countries tend to hold a major portion of their
foreign exchange reserves in USD, rather than in other currencies.
5. Weaponization of dollar
Weaponization
of dollar through economic sanctions by the US has forced countries, like,
Russia, China and Iran to diversify their foreign exchange reserves away from
US dollar. These countries also have been trying to transact in their own
currencies or other non-dollar currencies to the extent possible as part of their de-dollarization efforts.
Since 2014, Russia and China have been trying de-dollarization in order to challenge the mighty US dollar. They
seemed to have succeeded moderately in reducing their dependence on dollar.
Russia and China have reduced their use of dollar in bilateral trade.
Some Latin American nations, like Peru and Bolivia, have tried the de-dollarization process with some steps (like higher capital requirement for dollar loans), but with limited success.
In January 2023, Brazil and Argentina announced that they were discussing creation of a common currency for financial and commercial transactions -- as a counter to dollar's influence. But there is little progress since then.
At their Johannesburg Summit in August 2023, some BRICS nations expressed their aversion toward the US dollar and they also talked about an ambition for a BRICS currency. But this is too heterogeneous group to be taken seriously.
However, India has been diversifying its forex reserves for quite some time. The country's gold holdings in US dollar terms increased from just 3 percent in September 2008 to 7.45 percent in September 2023; an in volume terms from 358 metric tonnes to 800 metric tonnes in the same period.
Table showing India's gold holdings and forex reserves:
De-dollarization is hard for a world that is over-dependent
on the US dollar. What can dethrone the mighty dollar? Though Euro, British Pound
and the Japanese Yen are widely used currencies globally, there are far from
challenging the US dollar dominance.
The
US dollar has been the world’s dominant reserve currency since the end of
Second World War and is the most widely used currency for international trade.
British Pound used to dominate international trade in the early part of 20th
Century.
It
may be added British Pound started losing its dominance in the 1920s to the US
dollar.
High
demand for dollar means the US can borrow money cheaply though this has changed
in the past two years, as the US Federal Reserve has been rising interest rates
relentlessly.
The US government debt-GDP ratio is around 130 percent now, which used to be 100 percent 10 years ago. Such a high debt-GDP ratio is not sustainable in the backdrop of social security and medicaid benefits enjoyed by the US citizens.
Since the 2008 Global Financial Crisis, the US government debt has grown stupendously. It is now more than USD 33 trillion, up from around USD 22 trillion in 2019.
After the COVID-19 Pandemic, the US government debt has ballooned massively as the government provided stimulus checks to its citizens to ward off the negative impact of the Pandemic.
As the federal funds rate has increased from almost zero percent to 5.25-5.50 percent now, there are genuine fears about the US not being able to service its debt in future.
Despite several concerns, the US
dollar’s reserve currency status is likely to remain intact; Chinese Yuan
doesn’t have a chance to challenge dollar’s current status – at least for now.
There are capital controls in China and nobody wants to keep their assets in
Chinese Yuan.
China
is going to increase its usage of Yuan and but it is far from being a
challenger to the US dollar. In March 2018, Chinese government issued its first long
term contract denominated in Petroyuan, as an alternative to American
petrodollar.
Petroyuan
is a standardised oil futures contract available for trade on the Shanghai
International Energy Exchange (INE).
The
Western countries still run the global financial system, which has the following advantages: SWIFT
payment systems, controls on financial markets, economic sanctions, US dollar’s
reserve currency status, freezing forex reserves like they did with Russia after
Ukraine invasion and others.
The
world simply cannot live without the US dollars. De-dollarisation fears seem to have been
exaggerated. We cannot deal with China openly, we can’t create contracts with
China as we do with other nations, say, like the US. China has a lot of capital controls.
Chinese Yuan or any other currency is a long way
from being recognised as a global reserve currency.
The US dollar's hegemony is here to stay.
(Sorry folks, after the blog was posted online, I made several changes to the blog incorporating India's gold reserves and other points - I finished the blog by 11 PM on 04Nov2023)
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Additional
Notes: What is SDR?
The
SDR is an international reserve asset.
The SDR is not a currency, but its value is based on a basket of five
currencies—the US dollar, the euro, the Chinese renminbi, the Japanese yen, and
the British pound sterling.
The
IMF reviews the SDR basket every five years, or earlier if warranted, to ensure
that it reflects the relative importance of currencies in the world’s trading
and financial systems.
The
currency amounts remain fixed over the five-year SDR valuation period but the
weights of currencies in the basket fluctuate with exchange rates among the
basket currencies.
A
currency included in the SDR basket must meet two criteria:
1.
The export criterion
A
currency meets the export criterion if the issuing country is an IMF member (or
a monetary union that includes IMF members) and one of the top five world
exporters.
2.
The freely usable criterion
A
currency meets the freely usable criterion if it is widely used in payments for
international transactions and widely traded in the principal exchange markets.
SDR daily valuation
More Notes:
SWIFT - Society for Worldwide International Financial Telecommunications
Chinese
Yuan (CNY) is also known as Chinese Renminbi (RMB)
BRICS - a group of countries comprising Brazil, Russia, India, China and South Africa
The
US economy at market prices accounted for 29% of the world total GDP in 1975,
but only 24% in 2017.
The
share of US in global trade was 30% in 2000 and it declined to 25% in 2017.
The
USD’s share in global forex reserves was 71% in 2000 and it fell to 63% by
2017.
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References:
BIS– Bank for International Settlements working paper - USD share in forex reserves
BIS quarterly update Dec2022 - USD role
CurrencyComposition of Official Foreign Exchange Reserves (COFER) - historical data
IMF blog USD share in fx reserves falls
Tweet / X Post 11Aug2023 - mBrige central platform
Tweet / X Post 17Aug2020
RBI governor's boast on India diversifying forex reserves into gold and non-dollar currencies - BQ Prime Tweet (X Post) 21Mar2022 (this was after Russia invaded Ukraine; US and Europe imposed sanctions on Russia; and some countries were considering diversifying their forex reserves into non-dollar currencies -- due to fears of weaponization of US dollar by the US and Europe)
The above RBI governor (Shaktikanta Das) speech on 21Mar2022 at CII was uploaded on RBI website, but later was removed by RBI for some unknown reason - Tweet / X Post 31Mar2022
Note: Americans use weaponization while Brits tend to use weaponisation.
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Disclosure: I've vested interested
in Indian stocks and other investments. It's safe to assume I've interest in the financial instruments / products discussed, if
any.
Disclaimer: The analysis and
opinion provided here are only for information purposes and should not be construed
as investment advice. Investors should consult their own financial advisers
before making any investments. The author is a CFA Charterholder with a vested
interest in financial markets.
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